(NEW YORK) Say the economy has fallen into recession, as so many people on and off Wall Street think. Is it time to bail out of stocks?
Selling may be the reflexive response by shareholders who have watched the value of their assets decline in step with economic indicators, but investment advisers contend that they should consider buying instead. Recessions tend to be short, and by the time one is widely acknowledged, they say, investors have often sold just in time to miss the recovery that lies around the corner.
‘People should be preparing for the next upswing because the downturn is already priced in,’ advised Ron Muhlenkamp, manager of the Muhlenkamp Fund.
Brendt Stallings, a fund manager for the TCW Group who specialises in shares of medium-size companies, suggests that investors may not be fearing the worst but that they certainly have it on their minds. And that has already registered in stock prices.
Portfolio managers who foresee a rebound concentrate their buying on segments of the economy that tend to outperform as a new growth cycle gathers momentum. They are not allocating all of their resources to such recovery plays, though, and are making allowances for conditions that seem to be different from those of other recessions.
‘The normal rotation that occurs is a move into financials and consumer cyclicals,’ Mr Muhlenkamp noted before conceding that ‘normal’ does not quite describe the financial sector and such cyclical industries as housing these days. He likes some financial stocks, notably the mortgage buyer and seller Fannie Mae, but he prefers consumer-oriented companies like appliance maker Whirlpool and two transportation companies: Harley-Davidson and Winnebago.
Continuing with his eclectic list of companies that get people from here to there, he expects the stocks of Boeing and Caterpillar to rise with, or ahead of, the economy. A point in their favour, he said, is the level of the US dollar; it is far weaker than it was during the 2001 recession, giving American exporters a competitive edge.
Barbara Walchli, manager of the Aquila Rocky Mountain Equity fund, is another advocate of transportation stocks. The sector, she said, is ‘usually one of the groups that moves fastest coming off the bottom’.
One of the fastest of the fast may be Knight Transportation, a midsize trucking concern. Ms Walchli lauded Knight’s management for keeping the company’s books free of debt, unlike rival Swift Transportation, which she said had borrowed heavily to take itself private. She also likes Avnet, a distributor of electronic components to businesses. It fits well with her expectation that businesses will open their wallets before consumers as the economy emerges from its torpor.
Mr Stallings also foresees business spending picking up sooner, and he prefers potential beneficiaries of the trend that have a global reach.
Examples include Spirit AeroSystems, a supplier of commercial airline assemblies and components, and two companies, Cognizant Technology Solutions and Resources Connection, that provide outsourced labour to fulfil administrative or technical services for other businesses.
He also expects consumers to do their fair share in helping the economy bounce back. Among his favourite recovery plays here are three chains of different sorts: P F Chang’s China Bistro, which operates restaurants; pet supply company PetSmart; and Dick’s Sporting Goods.
‘It’s an interesting time to be a bottom-up fundamental growth manager,’ Mr Stallings said. ‘Everything is on sale across the board.’
Before buying stocks to anticipate a blast-off out of recession, investors must buy the premise that a recession is here. Many do not, including John Lynch, chief market analyst at Evergreen Investments.
‘The classic ingredients for a recession have been tight monetary policy and runaway inflation, especially wage inflation, and neither of those exists today,’ Mr Lynch said, despite some signs that inflation has been increasing.
He acknowledges that a third sign of recession – fear – is here, and then some, but he still describes the economy as being in ‘the late stages of expansion’ or possibly ‘knocking on the door of a recession’. That is only likely to postpone the reckoning until next year, he said.
In his view, the best companies in which to invest between now and then are in defensive areas like health care and basic consumer items, or in segments of technology that derive much of their revenue from businesses. Despite his less positive economic outlook, he, too, anticipates strong capital spending.
Defensive selections include Procter & Gamble, Pfizer and Johnson & Johnson. Among tech stocks that he mentioned are Intel, Microsoft and Oracle.
Even investment advisers who say the economy is approaching a trough prefer to hedge against the possibility that they are wrong.
David Fording, co-manager of the William Blair Growth fund, prefers consumer businesses that derive much of their sales abroad, where economic conditions appear less fragile. Mr Fording said he recently bought shares of the retailer Coach for that reason.
‘There are a number of growth drivers for Coach in the US and, more important, it’s a global brand,’ he said. His more conventional recovery choices include Fastenal, a supplier of construction and industrial supplies, and McCormick & Schmick’s Seafood Restaurants.
Such domestically focused companies are worth owning ‘if you feel that there’s a decent probability that we’ll make it through this rough patch’, Mr Fording said.
How rough will it be? He cautioned investors to expect conditions over the short term that are uncomfortable, but not necessarily unprofitable.
‘Regardless of whether we see really negative headlines for the next three to six months,’ he said, ‘it might very well be the case that the market climbs the wall of worry and looks past
the bad news to a recovery in 2009’.
Source: NYT (Business Times 5 Mar 08)